Insurable Interest Challenged In Life Insurance

Common law generally prohibits the purchase of a life insurance policy on a stranger’s life. But recently, a federal appeals court applied Wisconsin law to rule that a life insurer must pay $6 million to the bank-owner of a policy on the life of a stranger.

In 2007, Sun Life Assurance Co. of Canada issued a $6 million policy on the life of Charles Margolin, a wealthy 81-year-old man. U.S. Bank bought the policy in 2011, three years before Margolin died, on behalf of an investor in life insurance securities.

Apparently “securities intermediaries” like U.S. Bank pay cash for insurance policies on the lives of ill or elderly people, paying less than the face value of the policy, and bundle them together with other life insurance policies to be bought and sold as securities.

After Margolin died, U.S. Bank sought the life insurance proceeds. Sun Life, which had collected $2.5 million in premiums paid by successive policy owners, refused to pay.

Sun Life argued that U.S. Bank did not have an “insurable interest” in the policy on Margolin’s life, like the insurable interest a spouse or children may hold.

Without an insurable interest, Sun Life argued, owning a life insurance policy is akin to gambling on someone’s life, and Wisconsin law prohibits gambling contracts.

The U.S. District Court for the Western District of Wisconsin rejected Sun Life’s argument and ordered the insurer to pay the $6 million, as well as statutory interest and “bad faith” damages, payable when insurers lack a reasonable basis to pay a claim.

In Sun Life Assurance Co. of Canada v. U.S. Bank National Association, No. 16-1049 (Oct. 12, 2016), a three-judge panel for the Seventh Circuit Court of Appeals affirmed.

Judge Richard Posner, writing for the panel, noted that insurers can be required to pay life insurance proceeds to owners without an insurable interest under Wisconsin law.

“The common law remedy for buying a life insurance policy without having an insurable interest in the life of the insured was to invalidate the policy,” Judge Posner wrote.

The panel noted that in 1975, Wisconsin “changed the remedy from canceling the policy to requiring the insurer to honor its promise” while retaining the common law principle that forbids persons without an insurable interest from purchasing the policy.

The change, Judge Posner explained, was designed to deter insurance companies from selling life insurance policies to those without an insurable interest in the first place.

The statute, Wis. Stat. section 631.07(4), says “[n]o insurance policy is invalid merely because the policyholder lacks insurable interest … but a court with appropriate jurisdiction may order the proceeds to be paid to someone other than the person to whom the policy is designated to be payable, who is equitably entitled thereto. …”

“The statute changed only the remedy for violation, from invalidation of the policy to requiring the insurer to cough up the proceeds rather than …being allowed to keep all the premiums and pay noting to the policy holder because the latter had no insurable interest in the policy,” Judge Posner wrote for the three-judge panel.

The panel also concluded that U.S. Bank was entitled to the life insurance proceeds under the policy on Margolin’s life because “no one who is equitably entitled to the proceeds of the Sun Life policy has stepped forward to claim them.”

Finally, the panel ruled that U.S. Bank was entitled to interest of 12 percent per year, and bad faith damages for failing to timely pay the claim without a “reasonable basis.”